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Fuel For Thought

Kirit S Parikh

Oil price decontrol won't impact general public adversely.

| Feb 18, 2010, 00:00 IST

The impact of the recommendations of the expert group on pricing of petrol, diesel, kerosene and LPG on the poor and on the price level should be no more than that of present policy and most likely smaller over time. The group has recommended freeing petrol and diesel prices and some increases in prices of kerosene and LPG.
India imports 80 per cent of the petroleum consumed. When crude price increase is not passed through to consumers, the cost will have to be borne by oil marketing companies (OMCs). Since private OMCs would get out of a business if they made losses, it would be left to public sector OMCs to supply petroleum products at prices below their costs. If the OMCs are asked to bear the losses, they would go bankrupt. This would seriously compromise our energy security. Under-recoveries of OMCs are at Rs 46,000 crore in 2009-10.

The government can finance OMCs by raising taxes, cutting down expenditures, borrowing from the market or printing money. All these have consequences for price levels and economic growth, both of which affect people's real incomes.

The 2009-10 budget expects a total tax revenue of Rs 6,40,000 crore, of which Rs 2,65,000 crore are to be from indirect taxes. If indirect taxes are raised, the burden falls on people and the poor bear a larger burden relative to their income because indirect taxes are generally not progressive since progressive taxes collect little revenue. While income tax can be progressive, raising an additional Rs 30,000 crore over the estimated amount of Rs 1,07,000 crore will raise the tax rate by some 30 per cent and a tax at a high rate often gets evaded. The burden of corporate tax, expected to generate Rs 2,57,000 crore, may also fall in part on consumers in the form of higher prices.

If under-recoveries are financed through expenditure cuts such as lower investment in irrigation or reduced outlays on the programmes of Bharat Nirman, the burden also falls on the poor.

If deficit financing through market borrowing is done, interest rates, borrowing costs and production costs increase and investments go down. The country's credit rating also goes down with a higher fiscal deficit, and the costs of international borrowing increase. This raises prices also. Issuing bonds to PSUs is really financing by borrowing money. Printing money would have a direct inflationary impact.

Thus, no matter what you do or do not do, domestic prices will be impacted. The expert group recommendations should be examined in this context.

Freeing petrol price is a no-brainer, as vehicle owners need no subsidy. Also petrol consumption has little impact on other prices. With full pass through even at a crude price of $80 per barrel, an average two-wheeler driver would spend around Rs 50 per month more.

Consumers of diesel are passenger cars at 15 per cent, agriculture 12 per cent, trucks 37 per cent, buses 12 per cent, industry 10 per cent, power generators 8 per cent and railways 6 per cent. The owners of diesel cars, many of which are SUVs, can afford to pay more.

The Commission on Agricultural Costs and Prices while fixing minimum support prices compensates farmers for the cost of diesel. Thus, a higher price of diesel puts no additional burden on farmers, encourages them to use diesel and water more efficiently and reduces over-exploitation of groundwater.

Immediate increase in diesel price would be around Rs 2.5 per litre. Use by trucks, buses, railways, power generation and industry would increase costs but the impact on prices would be moderated as the higher diesel price would encourage freight movement by more fuel-efficient railways and competitive pressures. Thus the impact is not likely to be more than that of not changing present policies.

Kerosene price was set in 2002 at Rs 9 per litre. A lot of PDS kerosene gets diverted to adulterate diesel and for smuggling to neighbouring countries where the price is thrice as high. Households in the poorest decile in rural areas, which use 3.5 litres of kerosene per month, spend 2 per cent of their total expenditure on kerosene. The suggested increase puts no larger burden on the consumer budget than in 2002.

An increase of Rs 100 per LPG cylinder still leaves a subsidy of Rs 185. Sixty per cent of the LPG subsidy accrues to the richest 30 per cent of the population. The poorest 40 per cent in rural areas get only 0.6 per cent. The suggested price increase is less than the increase in per capita income of the urban population. Rationing to six cylinders per year would have meant a similar financial burden, encouraged an inspector raj and not curbed diversion.

The burden of our recommendations falls on users of petroleum products and not on the general public that bears the burden of inflation caused by present policies of managed prices. If inflation is its concern, the government can free petrol and diesel prices without increasing prices by reducing excise rates.

The writer, a former member of the Planning Commission, chaired the expert group on petroleum prices.

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